The 10-year outlook for home building is strong. Demographic tailwinds will support and grow demand for single-family, multifamily, and remodeled homes, particularly as the peak age of millennials moves to the early 30s and many of those in Generation X will seek newly built homes as they reach their prime earnings years. While a recession is possible in the medium-term, the largest risk to the long-term housing outlook remains the state of the nation’s public finances. In particular, unfunded promises regarding entitlements and public sector pensions constitute a serious fiscal risk over the next 10 to 15 years, threatening higher interests rates, tax rates, or inflation.
Updated numbers from the Congressional Budget Office (CBO) identify the issues clearly. In 2019, the amount of federal debt held by the public, including foreign owners, is expected to total $16.7 trillion. Consider this number as a share of the economy. For 2019, $16.7 trillion is 79.3% of gross domestic production (GDP). While elevated, this is nonetheless a manageable sum.
However, it is in future years that the problem comes into focus. The federal deficit is expected to total somewhat less than 5% of GDP per year over the next 10 years. As a result, the debt will grow to $28.6 trillion by 2028. The good news: The economy grows as well, so this expansion of debt only increases the debt as a share of GDP to 96%. The bad news: long-term fiscal projections indicate that the growth of entitlements (Medicare, Medicaid, and Social Security) continues into the 2030s, placing more strain on public finances. In 1990, these three programs represented only 7.7% of GDP. By 2017, their share had grown to 10.6%. To put that almost-3-percentage-point growth in perspective, in 2017 total defense/military spending was 3.1% of GDP. Total federal non-
defense, non-entitlement spending was just 3.2% of GDP last year.
There are two reasons why this matters for housing. First, the health of the residential construction sector is dependent on the overall economy’s prospects. A higher debt load results in “crowding out,” as investable funds are placed into government bonds rather than more productive business and research enterprises.
Second, to attract the additional funds needed to cover deficit spending, the government must pay higher interest rates. This is the key economic cost of a large national debt. Higher interest rates make investment in business and investment in housing more expensive. CBO projections hold the average interest rate on national debt fairly constant through 2028 at 3.5%. But due to the increase in principal (to more than $28 trillion), net interest payments by the federal government rise from 1.6% of GDP in 2018 to 3.1% of GDP in 2028. Thus, the budget for the Pentagon and the budget for interest payments are projected to be the same near the end of the next decade.
Some analysts suggest these problems are due to insufficient tax collections today or other government spending challenges, which is nonsense. The fundamental problem with these entitlement programs is that the number of taxpaying workers is too small to meet the promised obligations for a growing number of retirees. These fiscal impossibilities were established decades ago. For example, in 1960 there were 5.1 workers per Social Security recipient. By 1970, that ratio fell to 3.7. Today it is only 2.65 workers for each retiree. By the early 2030s, due to reduced population growth and longer life expectancies, the ratio will fall to only 2 people working for each person collecting Social Security, which means a higher fiscal burden on the labor force.
The economic and policy risk for housing is this: Unless policymakers make hard decisions about government spending over the next 10 years, interest rates and tax rates are likely going to have to increase to cover promises made before tomorrow’s home buyers’ parents were born. In fact, the CBO has estimated that to keep debt at about 80% of GDP (today’s level), tax revenues would have to grow 10% or spending would have to be cut 9% from projected levels for all years beginning today. This, in turn, will reduce economic growth and make it harder to buy a home.
While significant, these challenges are surmountable. Economic growth solves just about all problems. If today’s economic projections are underestimating technological and productivity growth, then these fiscal challenges will be more manageable. As such, policymakers should avoid changes that would hinder growth or development in the near-term. Markets are not currently spooked, but the clock is ticking, and no politically viable fiscal solutions yet exist.
